Want to avert another global recession? Stop the finger-pointing.
- By Mohamed A. El-Erian<p> Contributing editor Mohamed A. El-Erian is CEO and co-chief investment officer of global investment management firm Pimco and author of When Markets Collide. </p>
The global economic blame game is reaching a crescendo as Americans go to the polls and Europeans approach critical decision points. And everyone — from economists to central bankers, from TV analysts to the person on the street — seems to have a favorite scapegoat for Europe’s recession and debt crisis, for America’s feeble recovery and its recurrent political fiscal dramas, for dangerously high youth unemployment in a surprising number of countries, and for China’s sudden economic slowdown.
But four years into the global economic malaise that has followed the 2008 crash, the endless recriminations are more than just academic. They are actually preventing us from coming to a consensus not only on how to dig out of this mess, but also on how to prevent it from happening again. The unhappy result is that the risk of a global recession is rising, as is that of another financial crisis. So can we please get the finger-pointing out of our systems and move on?
Banks are at the top of most lists of bad guys. They lent way too much to credit-challenged entities, often using structured products like collateralized debt obligations and repackaged loans that few of them understood sufficiently, let alone knew how to manage responsibly. This lapse in the most fundamental element of banking — failing to properly channel loanable funds to productive uses — was consequential. Yet it was far from the only one.
Banks compounded the mistake by massively leveraging their balance sheets, making a whole set of expensive side bets, and moving activities to unregulated areas. Many did so while benefiting from the protection afforded to them by state-run deposit guarantees, emergency loans from central banks, and, most destructive of all, the notion that they were "too big to fail."
To add insult to injury, many banks (particularly in the United States) are seen as now overreacting. Having lent way too much and in a reckless manner, today they are withholding credit from legitimate borrowers, preferring just to add to the capital they’ve stockpiled at the Federal Reserve.
Even as I write this, I can hear the bankers shout, "Unfair!" Many of them argue that these crises are due to regulators falling asleep at the switch. They have a point.
Enamored with the textbook characterization of efficient, unfettered capitalism and well-functioning markets, regulators gave the banks an enormous amount of rope with which to hang themselves. In the process, they aided and abetted the illusion that banks could operate outside the constraints of the real economic activity that they finance. The laxity was intensified by competitive hubris — among cities vying to be the world’s financial center (London vs. New York) and among others that, in a quest for greater international respect, allowed their national banks to vastly outgrow domestic realities (Dublin, Reykjavik, and Zurich).
"Not so fast," respond the regulators, who invariably rebut the finger-pointing by arguing that the politicians pushed them to turn a blind eye or, even worse, deregulate beyond what prudence would have dictated. And the politicians wouldn’t let up, believing that leverage could deliver sustainable economic growth to an impatient electorate.
After all, the West was (and is) increasingly losing out to emerging economies that benefit from lower wages, technology leapfrogging, or considerable natural resource endowments. Too many Western governments fell prey to the idea that advanced economies, in a bid to retain their global standing, could simply migrate up the value-added curve from producing things to financing them (and then trading over and over again a seemingly endless array of derivatives).
To which the politicians, of course, will say: "It’s not our fault. Without a level economic playing field, we’re forced to take risks to compete." In their version of reality, emerging economies gained competitive advantage by manipulating their currencies, weakening labor standards, degrading the environment, or engaging in various forms of implicit protectionism — complaints that resurfaced in America’s presidential campaign, pushing candidate Mitt Romney to threaten to label China a "currency manipulator."
These same politicians are also quick to point the finger at "do-nothing" multilateral institutions, claiming that the lapses leading to the crisis were a reflection of poor governance at global bodies like the International Monetary Fund (IMF), whose very purpose is to blow the whistle on unsustainable national policies, especially if they risk harming other countries. Remember, the raison d’être of the IMF and other multilateral institutions is to promote and facilitate global cooperation and shared policy responsibilities. Yet, when push came to shove, these institutions shied away from their duties, hindered by widespread representation and legitimacy deficits.
Then again, the multilaterals will say, "Don’t blame us. We’re only as strong as our member nations let us be." Fair enough: For many years, a number of key countries acted to undermine responsible multilateralism. Western countries stubbornly held on (and still do) to their outmoded entitlements at the IMF and World Bank, from absurd voting overrepresentation to feudalistic strangleholds on key decision-making positions. For their part, emerging economies were too timid in forcing much-needed change.
"How could we?" ask these emerging economies. After all, the last thing they wished to do was alienate powerful politicians in Europe and the United States who were too timid to face reality, shying away from the responsibility of explaining to their citizens the reality and consequences of global economic realignments. These same politicians — hostage to the tyranny of short election cycles — instead wooed voters seeking instant gratification, the protection of unsustainable entitlements, and shortcuts to continued prosperity. All this brings us back to the banks, the beginning of this vicious circle of blame. I mean, who else could have enabled these voters to consume as they wanted, inflating their living standards based not on income but credit?
And so go the endless, useless recriminations. The blame game, however, is a lot more dangerous than it sounds. This never-ending cycle not only diverts responsibility, but distracts from coherent responses. That has two immediate consequences.
First, it is virtually impossible to generate the sense of shared responsibility that must underpin any sustainable, effective solution. And while we dither, the global malaise spreads: Unemployment remains too high, financial fragility grows, and healthy capital retreats to the sidelines. Meanwhile, a growing number of weak economies now risk being tipped into severe crises while the stronger ones see their vibrancy sapped by global instabilities. Just witness the sharp slowdown in Germany — Europe’s strongest economy — and the related rise in unemployment. Or look at how growth is plummeting in once vibrant emerging markets such as Brazil, China, and India. The longer the blame game continues, the greater the scope and scale of the synchronized global slowdown.
Second, the temptation increases for each country to turn inward, significantly raising the risk of protectionism. In today’s world, this risk is not limited just to trade and currency wars. If we’re not careful, a cascade of capital controls — gates that stop money from flowing around the global system — could be on the horizon, severely undermining the functioning of the open markets our economies have come to rely on and risking a further deterioration in growth and job dynamics. That’s something we can ill afford.
There is no time to waste. Instead of a blame game, we need a cooperative game. And whoever wins the U.S. election in November must make this priority No. 1.
The world is looking for bold economic leadership, and in the absence of it, dysfunction that will make 2008 merely a flesh wound risks becoming an ever more likely reality. And trust me — no one will want to take the blame for that tragedy.